You’ve developed THE invention that will change the landscape of the cannabis space but … How to pay for it? The perennial problem of having a great idea without the capital to fund it unfortunately also extends to the marijuana industry. Who should you turn to? Will raising money from friends and family be sufficient to power your cannabis startup? Often times, the answer is no and as more ambitious marijuana entrepreneurs develop ideas that will require large sums of money, venture capital (VC) firms are the only viable outlets available to meet this demand.
Canna Pride and Prejudice: So You’ve Got Their Attention
It goes without saying that VC investors are on a daily basis pitched an endless number of ideas and business proposals. Phone calls, meetings, and conference calls – it is the job of the VC to continuously scout new companies that are promising and capable of returning a meaningful return on their investment.
Coupling the regularity with which VC firms hear new ideas with the added risk of investing in the Cannabis industry (due to the inanity of Marijuana’s federal illegality), it is understandable that marijuana startups that finally make it through the grueling selection process and receive an offer from a VC firm are irresponsibly zealous in their accord. These companies have done what so many before them have not and are now one step closer to raising a serious amount of capital! While the temptation to immediately say yes and agree to the VC’s financial offering is enormous, entrepreneurs should and indeed must tread carefully and think through the ramifications of the offer before giving away too much equity in their company.
First … The Good
Clearly, the major benefit of accepting VC money is the immediate (and seemingly painless) infusion of capital – A company’s bank accounts are empty one day and plentiful the very next! This infusion allows startups to continue to support themselves and their associates while paying their employees, vendors, miscellaneous expenses etc. Furthermore, VC money provides an indirect method of financial support through new connections with talent and partners. Indeed, VC firms are quick to tout their “connections” in the industry and often tease the promise of trickle down financing; the mere presence and backing of the VC firm will by definition convince and compel a new batch of investors and buyers to also support the company. Canna startups with more money have greater capacities to hire new talent and enter markets that would otherwise be unavailable to them.
Finally, beyond the immediate financial implications of a cash infusion, VC firms typically have great experience and knowledge in navigating through the treacherous world of Startups. Where and when to launch the product? Which banks to use? Which financial advisors can be trusted? The marijuana industry is particularly precarious and having an experienced team of VC investors steering the ship can be extremely useful for founders lacking certain business fundamentals. Thus, in theory, as cash injections from VC firms increase, so too does the growth of the company.
Tempting To Accept VC Cash …. But At What Cost?
Hopefully, the (potential) benefit of getting into bed with VC firms is now obvious and tantalizing. Who doesn’t want to receive money and advice from established venture capitalists? Well, people who understand the cost of this relationship. First and foremost, it is critical to remember that these VCs are not giving away money but are rather investing money in exchange for something.
Typically, this “something” is equity in the company. The marijuana startup is receiving a certain amount of money at a certain valuation from the VC because the VC expects that equity stake to be worth more at a later date. Naturally, it is in the VC’s best interest to grab as much equity as possible during the negotiation period while it is in the startup’s best interest to retain as much equity as possible. Therefore, Startup’s should be skeptical of any VC offers that seem too disparate in value – if you feel like the VC is ripping you off, you are probably right.
Beyond the sordid potential of being taken advantage of on the financial side of the deal, VCs often want to retain a certain amount of managerial control over the company. Specifically, this is often negotiated in the form of board seats where VCs will demand a representation on the board along with voting rights on key issues. How many more rounds of funding can the startup undergo? At what valuation? How will the dilution of equity be structured? Can the funding only occur after a certain threshold amount of capital has been amassed? While the cannabis startup and investor-VC might share the same ultimate objective of making money, they will likely have divergent views on the best way to get there.
A Godly Gift Or A Deal With The Devil?
Make no mistake about it – entering into an agreement with a VC company is just as serious of a decision as choosing your future spouse. VCs can gain a tremendous amount of power over the startup and while this is not necessarily a bad thing, it is critically important for the startup to be aware of what in fact they are both gaining and losing. The VCs are looking out for themselves and so too should you. Ultimately, select your venture capitalist firm wisely and as always #protectyourstash.
Abe Cohn manages THC Legal Group, a Marijuana Law Firm specializing in the cannabis industry. Their attorneys assist startups, entrepreneurs and established businesses protect their most prized assets. Connect with them to learn more.
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